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Escrow definition: What an escrow company does

Erik J. MartinThe Mortgage Reports Contributor

In this article:

What is escrow? It means placing something of value in the care of a neutral third party until specified conditions are met. This makes real estate transactions safer and smoother.

  • Buyers may put up an earnest money deposit. The escrow company holds it until the sale closes
  • If the seller has a mortgage on the property, the escrow company pays it off with the sale proceeds
  • Escrow officers also disburse other expenses like real estate commissions and lender fees

Escrow companies make everything safer. So you can get your earnest money deposit back if the sale doesn’t go through, as long as you abide by the contract.

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Understanding escrow

The concept of “escrow” is important in real estate. There can be up to three different kinds of escrow involved when you buy a home. It helps to understand these differences and how escrow works.

Opening escrow

In many cases, an escrow officer or attorney holds the funds associated with a transaction until it closes or fails to close — for instance, you probably paid an earnest money deposit when your offer was accepted.

If you are using a mortgage to buy your home, your lender will issue instructions to the escrow officer. He or she will receive the balance of your deposit and closing costs, and your lender may wire the rest of your purchase price.

The closing

The escrow officer also pays out funds as instructed — paying pay off any mortgage balance owed by the sellers, commissions to the real estate agents, other providers like inspectors, and, finally, the sellers. Sometimes, money remains in escrow after closing for required repairs that take place later.

Related: Closing day (When can I get my keys and move in?)

You’ll probably also sign your final documents on your closing day. However, it’s better if you can get a copy of them in advance and go through them with more time and less pressure.

Ongoing escrow, aka “impounds”

One type of escrow happens after closing. Many lenders prefer to pay the homeowners insurance and property taxes themselves. They add 1/12th of that amount to the monthly payment, then pay the taxes and insurance premiums when they come due. These amounts are also called “impounds” or “escrows.”

This can really add to your closing bill, because the impound or escrow account is “front loaded” with a few months of payments.

Is escrow a good thing?

Ultimately, escrow helps protect both the buyer and seller. That’s because a neutral third party handles the money and holds funds securely. And it disburses money on time to the lender, agents, taxing bodies and other parties. This prevents disputes. Plus, it makes matters much easier for buyers and sellers.

Related: How can I avoid having an escrow or impound account?

Escrow for taxes and insurance is not always the choice of homeowners who prefer to control their own expenses and payment schedules themselves. If their down payment exceeds 20 percent, they may be allowed to skip the monthly escrows (impounds). Sometimes, they may have to pay a fee (usually .125 percent) for the privilege.

Ask questions about anything you’re not clear about. Learn about the costs involved. And choose escrow professionals you can trust.

Other escrow duties

Escrow officers don’t just oversee funds and paperwork. Francis Betancourt-Molina with Florida Capital Bank says they can serve other crucial functions, too.

“They can order services agreed upon by the parties,” she says. “These include ordering home inspections, surveys, title search, and title commitment. They work to clear any title exceptions on the property.”

Escrow officers have plenty of closing duties, as well.

“They walk the parties through the signing of the loan closing documents. They send the mortgage instruments to the county clerk for recording. And they send the closed loan package to the lender,” she adds.

Also, “They make sure that prior loans are paid off. They check that taxes due have been paid, and that current tax years have been prorated,” says Bruce Ailion, Realtor and real estate attorney.

Steps involved in escrow

Betancourt-Molina says first and second types of escrow often involve these steps:

  1. Seller and buyer agree on a purchase contract
  2. Buyer provides an earnest money deposit held by the escrow officer
  3. Escrow officer works with the seller and agents to clear any title problems
  4. Both parties agree on a home inspection, ordered by the escrow officer
  5. Escrow officer provides the lender with a title commitment
  6. Escrow officer reviews the initial closing disclosure. He or she then issues the final disclosure
  7. The escrow officer closes the transaction

While listing agents often prefer the buyer to use their favorite closing agent, along with the agent’s title insurance and settlement services, Section 9 of the Real Estate Settlement Procedures Act (RESPA) prohibits sellers from forcing you to use a specific title insurance company.

Escrow requirements

Every home purchase usually requires the first type of escrow: the holding and disbursement of earnest money by a third party.

“When you make a deposit, it’s almost always required that a third party escrow officer hold those funds in escrow. But it doesn’t have to be an escrow company,” says Ralph DiBugnara with Residential Home Funding. Instead, it can be an attorney, closing agent, or title company.

The seller or seller’s agent likes to pick the escrow officer/company.

“But the buyer doesn’t have to agree. The parties can negotiate who to use,” says Betancourt-Molina. “On mortgage refis, the borrower picks the escrow agent. In this case, the lender can provide a list of suggested companies to the buyer.”

Related: 6 ways home buyers are lowering closing costs

RESPA doesn’t care if the seller requires a certain title company if the seller pays for both the owner’s and lender’s title insurance policies. But the seller or seller’s agent cannot legally make the buyer pay for both the owner’s and the lender’s title insurance policies and also insist on choosing the provider.

Many states also require the second type of escrow: closing using an escrow process.

“This helps satisfy the lender,” Betancourt-Molina says. “They need to confirm that there are no unacceptable title impediments, survey exceptions, unpaid taxes, or liens against the property.”

Lastly, many lenders require the third type of escrow: the holding of extra funds in an escrow account to pay taxes and insurance. They may handle this process themselves or hire a loan servicing company to do it for them. Every year, lenders examine the escrow account and adjust it if necessary.

Costs

DiBugnara says fees for escrow services can vary.

“Thankfully, the borrower is not charged when their deposit is held and paid out by the escrow officer,” he says.

Other services come with a price. These include duties like ordering surveys, handling title matters, and assisting in closing.

“The escrow company determines these costs. But the charges must be customary and reasonable for the area,” Betancourt-Molina says.

Related: Average mortgage closing costs in the US (How do you stack up?)

“In my state of Georgia, the attorney fee could be $500 to $1,000. Title search can cost $250 if the title is clean. A tax search costs about $50. And title insurance fees vary based on the price of the property,” says Ailion.

Per the National Association of Realtors, escrow costs add 1 to 2 percent of the cost of the home. Often, the buyer and seller split the charges, depending on local custom. Of course, everything is negotiable, and when you refinance, those costs are all yours.

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